In a recent decision, the U.S. District Court for the District of New Jersey, relying on the Circuit’s decision in In re Telegroup Inc., 281 F.3d 133 (3d Cir. 2002), held that claims for payments due under a make-up provision in a stock purchase agreement were “damages arising from the purchase or sale of …a security” and thus subject to automatic subordination under §510(b) of the Code. Queen v. Official Committee of Unsecured Creditors (In re Response U.S.A. Inc.), Civil Nos. 02-4975, 02-5283 (JBS) (D. N.J. Jan. 27, 2003). In Queen, the stock purchase agreement included a provision to protect the selling parties if the stock of the acquirer (and eventual debtor), which was used as consideration in the stock purchase, declined in value. In the event of a decline in value, upon a sale of the stock by the holders, the acquirer entity would pay the holders the difference between the purchase price and the sale price in stock or cash (and the “make-up” payment had to be cash in certain defined circumstances). When the acquirer filed its petition for relief, the stock became worthless and the holders filed proofs of claim for the amounts due under the “make-up” clauses. Upon objection, the bankruptcy court held that the claims had to be subordinated under §510(b). Upon appeal, the District Court affirmed, finding that even though the claims were for payments due under the agreement, they were nonetheless claims for “damages” under §510(b) with a “nexus” to the purchase of the securities under the test in Telegroup. The court stated that “a shareholder, who accepts the benefits of stock ownership along with the risk that the company will go bankrupt, should not be able to avoid subordination under §510(b) by placing a risk-limiting provision in the Stock Purchase Agreement to claim creditor status in the bankruptcy proceedings.” Queen, slip op. at 14. See also, In re Int’l Wireless Comm. Holdings Inc., 279 B.R. 463, 468 (D. Del. 2002) (similar provision).
